Educational Articles

Stock Screen: Conservative Stocks - July 23, 2012

Nira Maharaj
| July 23, 2012

Value Line offers a number of proprietary measures to help investors identify so-called conservative stocks, the most notable being the Safety Rank. This measure is computed by averaging a stock’s Price Stability score and the company’s Financial Strength Rating. Safety Ranks range from 1 (Highest) to 5 (Lowest) and are distributed roughly in a bell curve, with the greatest number of stocks scoring 3 (Average) and the smallest number at the extremes (i.e. 1 and 5). Thus, selecting stocks that hold the best possible scores (i.e., 1 or 2) would help investors to avoid riskier fare.

Value Line provides screens each week, published in the Summary & Index section of The Value Line Investment Survey, that cull out stocks earning the 1 (Highest) Safety Rank and the 2 (Above Average) Safety Rank (presented as two separate screens). This alleviates the need to rummage through on a stock-by-stock basis, trying to find the most conservative issues. A couple of interesting stocks that recently made these elite lists include: Berkshire Hathaway (BRK/B) and Merck and Co. (MRK).

Berkshire Hathaway

Berkshire Hathaway is a holding company that owns a number of subsidiaries in several different business areas. Insurance is the company’s main business focus. It engages in property and casualty insurance both directly and through reinsurance channels under the GEICO, General Re, and Berkshire Reinsurance names. The company also engages in other business activities such as electric utilities, with a current 89.8% common stock interest in MidAmerican Energy Holdings. In addition, it is involved in candy manufacturing, fine jewelry, newspapers, manufactured homes, and other markets.

Berkshire’s wide business reach ought to enable it to realize top- and bottom-line growth in the near term as well as over the 3- to 5-year period. Indeed, as the economy slowly improves, the company ought to benefit from multiple avenues, such as increased railroad activity, a boost in the housing market, and other businesses such as jewelry, all of which should improve once consumers are spending more freely. Further, its insurance business is doing well, especially GEICO, which continues to attract new customers thanks largely to its hefty advertising budget.

Conservative investors may find these shares attractive. First, the balance sheet is solid, with the company’s latest cash balance amounting to around $38 billion, along with a negligible amount of debt. The strong Financial Strength of the company gives Berkshire several expansion opportunities such as acquisitions, which it will likely pursue in order to expand BRK/B’s market reach. Furthermore, the equity has obtained our Highest Safety score, another indication that this stock is not as susceptible to volatile market swings.

Merck & Company

Merck is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies, animal health, and consumer care products, which it markets directly and through its joint ventures. Operations consist of four segments, namely: Pharmaceutical, Animal Health, Consumer Care, and Alliances. Major market-approved drugs in the portfolio include Singulair (used for respiratory ailments), Remicade (arthritis), Zetia and Vytorin (cholesterol), and Januvia (diabetes). Merck also has animal health products which it sells to veterinarians, distributors, and animal producers.

In light of upcoming patent losses such as for Singulair, and the likelihood of increasing generic competition, Merck will likely rely heavily on research and development endeavors over the next few years. Indeed, new product rollouts are expected to help capture market share as it prepares to lose contributions from prior star sellers. However, we are optimistic that the company will be able to mitigate these difficult operating conditions through a promising pipeline that should bear fruit in the upcoming years. Also, a reduced cost structure, scheduled to be implemented in the second half of 2012, should aid near-term bottom-line advances.

Merck shares have several attributes that should appeal to conservative investors. The stock possesses our Highest Safety rank and has the top score for Financial Strength. The lower-than-market Beta coefficient also suggests that there is minimal risk to investing in these shares.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.